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Why Realord Group Holdings Limited’s (HKG:1196) Return On Capital Employed Looks Uninspiring

Simply Wall St

Today we are going to look at Realord Group Holdings Limited (HKG:1196) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Realord Group Holdings:

0.0047 = HK$54m ÷ (HK$13b - HK$1.4b) (Based on the trailing twelve months to June 2019.)

Therefore, Realord Group Holdings has an ROCE of 0.5%.

Check out our latest analysis for Realord Group Holdings

Is Realord Group Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Realord Group Holdings's ROCE is meaningfully below the Industrials industry average of 3.7%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Realord Group Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. Readers may wish to look for more rewarding investments.

Realord Group Holdings delivered an ROCE of 0.5%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. The image below shows how Realord Group Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:1196 Past Revenue and Net Income, November 1st 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Realord Group Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Realord Group Holdings's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Realord Group Holdings has total liabilities of HK$1.4b and total assets of HK$13b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Realord Group Holdings's ROCE

Realord Group Holdings has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Realord Group Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Realord Group Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.